What Banks Need To Know When Clients File For Bankruptcy September - - PowerPoint PPT Presentation

What Banks Need To Know When Clients File For Bankruptcy

September 13, 2012

Squire Sanders (US) LLP

Bradley A. Cosman Jeffrey S. Renzi Bankruptcy & Restructuring Associate Litigation Senior Associate 1 E. Washington Street, Suite 2700 555 S. Flower Street, 31st Floor Phoenix, AZ 85004 Los Angeles, CA 90071

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Outline

• Automatic Stay under Bankruptcy Code § 362
• Financing the Bankruptcy - Cash Collateral and

DIP Financing

• Impacts of Collateral Valuation
• Pre-Bankruptcy Remedies

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Automatic Stay

• One of the most important protections for

debtors

• Nationwide, possibly even worldwide,

injunction barring almost all actions against the debtor and its property

• Triggered automatically upon filing
• Purpose

– Provide debtor with a breathing spell from pressure and demands of creditors – Prevent “race to the courthouse” - depletion of the bankruptcy estate in favor of one creditor at expense of others

• Violators subject to sanctions

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Automatic Stay

• Enjoins, among other things:

– Exercise of remedies with respect to collateral; – Enforcement of prepetition judgments; – Litigation; – Informal collection efforts, such as calling the debtor or sending threatening demand letters; – Acts to create, perfect and enforce liens granted before the petition date; and – Application of Setoff (netting prepetition debt owing to the debtor against a claim asserted against the debtor arising from a different transaction)

• But, consensual negotiations with debtor are

permitted

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Automatic Stay

Limitations – Actions Against Non-Debtors Automatic Stay does NOT extend to non-debtor third parties (e.g. guarantors, affiliates, co-debtors,

• fficers and principals, co-defendants and

partners)

• But . . . Bankruptcy Court’s have extended stay

to non-debtors when a claim against the non- debtor will have immediate adverse economic consequences for the bankruptcy estate

• Known as a “§ 105 Injunction”
• E.g. – Action against the non-debtor principal / guarantor of

small company may be enjoined due to “identity of interests”

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Automatic Stay

Limitations – Letters of Credit

• Stay does NOT prevent a beneficiary to

draw down on a LOC issued on account

• f a debtor

– Stay does not apply because LOC is not property of the estate

• Once drawn down by the beneficiary, the

lender issuing the LOC immediately has a secured claim against the debtor for reimbursement

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Automatic Stay

Exception – Postpetition perfection of prepetition security interest allowed in 2 situations:

• Retroactive Perfection Permitted by Non-

Bankruptcy Law

– E.g. – Purchase Money Security Interest (PMSI) – But, must still perfect in the statutory grace period

• Filing UCC Continuation Statement

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Automatic Stay

Relief from Stay

• May be granted by the court on its own, or on request

from a party-in-interest after notice and hearing

• Courts may be reluctant to grant relief early in case,

but lenders should still consider seeking relief as a means to:

– Ensure provision of adequate protection – Force debtor to respond – Create a baseline to establish cause for subsequent stay relief

• E.g. – failure to make adequate protection payments; lack
• f progress; diminution in value

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Automatic Stay

Grounds for Relief from Stay

• 1. “For Cause” - Including Lack of Adequate

Protection

a) From a secured lender’s perspective, this is the most important basis for relief b) Secured creditors are entitled to “adequate protection” to protect against diminution in value of their collateral during the bankruptcy case

i. Diminution can be caused by variety of factors, including depreciation, physical loss, or damage ii. These types of losses are attributable to the Automatic stay

c) But, an equity cushion in collateral may be deemed adequate protection (measured only as to specific creditor’s lien, not all liens)

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Automatic Stay

Grounds for Relief from Stay

• 2. No Equity in Collateral & Collateral Not

Necessary to Reorganization

a) The first requirement is satisfied if the total of all encumbrances exceeds value of the property. b) The second requirement requires the debtor prove that the property is subject to an effective reorganization with a “reasonable possibility of success within a reasonable time” c) As a practical matter, obtaining stay relief on these grounds is difficult early in case.

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Automatic Stay

Grounds for Relief from Stay

• 3. Single Asset Real Estate cases

a) Single asset real estate (“SARE”) cases essentially involve business operations with a single real estate property or project other than residential real property. b) SARE cases are usually two-party disputes c) Lender will be granted stay relief unless one of the following occurs within the first 90 days of the case: i. The debtor files a plan that has a reasonable possibility of being confirmed in a reasonable time frame; or ii. The debtor commences monthly interest payments at the non-default contract rate

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Automatic Stay

Grounds for Relief from Stay

• 4. Bad Faith filing

a) The Automatic Stay may be lifted if the bankruptcy court finds that the case was filed as part of a scheme of delay, hinder, and defraud creditors. b) SARE cases are usually two-party disputes c) Lender will be granted stay relief unless one of the following occurs within the first 90 days of the case:

i. The debtor files a plan that has a reasonable possibility of being confirmed in a reasonable time frame; or ii. The debtor commences monthly interest payments at the non-default contract rate

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Automatic Stay

Waivers

• Bankruptcy Code does not expressly prohibit

prepetition anticipatory waivers of the automatic stay

• Regardless, lender MUST file a motion for relief

from stay to enforce the prepetition waiver

• Prepetition waivers are considered on a case-by-

case basis along with other factors such as sophistication of parties, timing, consideration, evidence of coercion, and other circumstances

• Most prevalent in SARE cases

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Financing the Chapter 11

DIP financing, or Cash Collateral, or Both

 The Debtor must have access cash to finance postpetition

• perations. If unencumbered cash and cash collateral are

insufficient, then the debtor must obtain DIP financing

• Cash Collateral – Cash generated from the sale of

prepetition inventories or collection of prepetition receivables

• DIP Financing – New money lending to the debtor,

usually on a priming basis

• Cannot force a lender to provide DIP Financing

under the Bankruptcy Code

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Financing the Chapter 11

• Cash Collateral can only be used by the

debtor with the creditor’s consent or if the court, after notice and a hearing, finds that the creditor is adequately protected and authorizes the use

• What constitutes adequate protection? Three

non-exclusive methods

– Cash payment or periodic payments – Additional or replacement liens – “Indubitable equivalent” – (defined by case law, essentially something of equivalent value)

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Financing the Chapter 11

• Bankruptcy Code provides incentives to

encourage creditors to lend to debtors using DIP financing

• Can be structured as asset-based revolvers

advanced against a borrowing base, or as term loans

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Financing the Chapter 11

• Four variations of DIP financing:

– Unsecured financing with super priority claims

• Lenders should avoid if possible

– Financing secured by liens on previously unencumbered assets – Financing secured by junior liens on previously encumbered assets – Financing secured by senior or priming liens on previously encumbered assets

• Only available as last resort
• Require consent of prepetition lender or evidence of

adequate protection

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Financing the Chapter 11

• Reasons and Benefits for Providing DIP

Financing

– Large transaction fees – High interest rates – Low repayment risk / strong collateral position – Control – establishing milestone deadlines, require retention of CRO, etc. – Loan-to-Own (offensive) – strategic play contemplating conversion of deb into controlling equity position – Improved Priority/Increased Collateral/Validation of Liens and Releases (Defensive)

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Collateral Valuation

• General Rule: Oversecured creditors may

receive postpetition interest payments, but undersecured and unsecured creditors generally do not

– Oversecured creditors may also be entitled to attorneys’ fees, professional fees, and other similar fees if provided for by contract or statute – Some courts allow undersecured and unsecured creditors to add postpetition fees and costs to their unsecured claim if provided for by contract

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Collateral Valuation

• When is collateral valued?

– Depends on the circumstances and purpose of the valuation, but is frequently the confirmation date’

• How is collateral valued?

– Depends on the type of debtor and nature of collateral

• Real estate - fair market value based on sales comps
• Operating entity – discounted cash flow, sales

multiple

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Collateral Valuation

• An undersecured creditor ends up with two

separate claims, a secured claim in an amount equal to the value of its collateral, and an unsecured deficiency claim for the balance

• Nevertheless, undersecured creditors can

elect to have the entirety of their claim treated as a secured claim under Section 1111(b)(2)

• f the Bankruptcy Code

– Effects and requirements of 1111(b)(2) are complicated and whether to make an 1111(b)(2) election should be carefully considered

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Provisional Remedies

• If undersecured, goal is to secure more

assets

• Possible options, pre-bankruptcy petition:

– Writ of attachment – Receivership

• Each require the filing of a lawsuit (e.g.

breach of contract claim), which will be subject to the automatic stay if the debtor files a bankruptcy petition.

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Writ of Attachment

• Creditor must establish that it has a

commercial claim based upon a contract, and that there is a probable validity of the creditor’s claim in the action.

• May be obtained without notice, if the

creditor is able to demonstrate great or irreparable injury.

• Unavailable if creditor is fully secured by real

property.

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Writ of Attachment

• If debtor files a bankruptcy petition after the

attachment:

– Only a perfected lien is a secured claim. – In California, a writ of attachment lien is not perfected until a judgment has been entered. – Creditor may seek a relief from stay in order to permit the creditor to obtain judgment and perfect the lien.

• In re Aquarias Disk Services Inc., 245 B.R. 253 (9th
• Cir. 2000) (court allowed relief from stay to pursue

state court action)

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Writ of Attachment

• Should be considered where:

– Creditor is undersecured. – Debtor is distressed, yet has significant assets that may be subject to attachment. – Creditor has reasonable belief that debtor may attempt to dissipate its assets.

• Downside:

– Costs – Could push a debtor into bankruptcy

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Receivership

• Receiver is a person appointed by the court

to take charge and management of property subject to litigation.

• May be appointed where property in danger
• f being lost, removed, or materially injured.
• Extraordinary remedy that is often costly.

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Questions & Answers